• Real Assets
  • Real Estate
  • European Real Estate

European real estate: three predictions for 2018

The European economy is enjoying strong growth, but with real estate investment markets advanced in the cycle, value is becoming hard to find. Monika Sujkowska discusses what’s in store for the European real estate market in 2018.

3 minute read

door number 3 in gold

In his annual speech in September, European Commission President Jean-Claude Juncker claimed “the wind is back in Europe’s sails,” and with some justification.1 Euro zone GDP expanded by 2.5 per cent year-on-year in the third quarter – well above trend – and unemployment fell to 8.9 per cent, down from 9.9 per cent a year earlier.

Our projections indicate that if the region continues to grow at the current pace, it is likely to reach full economic capacity at the end of 2018. Until then, inflation should remain muted, lagging the two per cent target set by the European Central Bank (ECB). The bank will be able to take its time in normalising monetary policy, and with monetary conditions remaining loose, real estate will continue to look relatively attractive compared with other asset classes, driving further investment activity. By late 2018 or early 2019, however, the ECB is likely to begin hiking interest rates from their current, unprecedentedly low levels.

Given we are at a late stage in the investment cycle, investors should follow a few rules of thumb: focus on assets in places that are likely to see sustained occupier demand, and avoid properties in structurally-weaker locations, even if they are currently well let.  We recommend zeroing in on cities with a diverse local economy, healthy demographics and a high share of knowledge-intensive employment, which should stay relatively resilient amid the rise of automation.

Here are our three predictions for the key trends that will shape European real estate markets next year:

1. Solid rental growth will continue

We expect fundamentals will continue to improve over the next 12 months. Retail sales are strong and industrial production is surging. The Markit Manufacturing Purchasing Managers’ Index (PMI) for the euro zone rose to an impressive 60 in November – the highest level in more than 17 years. These trends are likely to foster rising occupier demand throughout 2018. With a scarcity of supply – the amount of empty space in the office sector has declined to almost pre-crisis levels – rising demand should result in positive rental growth in most markets. Rental growth is expected to soften from 2019 onwards as supply increases.

2. The last year of strong returns

Our five-year outlook suggests 2018 will be the final year in which investors can expect strong returns on European property. We forecast total returns of 6.7 per cent across prime European commercial real estate assets next year, but the average annualised return will be much lower between 2018 and 2022, at 2.6 per cent. A normalisation of yield levels from 2019 is the main reason behind our forecasts for softer returns, with the impact unlikely to be sufficiently offset by rental growth.

It would be prudent for investors to consider selling weaker assets over the next 12 months, especially those located in markets that are likely to underperform in the next stage of the cycle (see our over/under pricing analysis in figure 1). Investors should avoid properties exposed to income risk and limit their use of leverage, as declining capital returns and rising borrowing costs will reduce returns on investment over the medium term. Real estate debt is likely to offer better risk-adjusted returns than equity investments, as it will shield investors from the impact of capital declines.

Figure 1. Under/over pricing analysis 2018-20222
graph showing under over pricing analysis from 2018-2022

3. Prime retail and industrial sectors will outperform offices

Selected markets will offer value to investors with medium-term investment horizons in 2018. Prime industrial assets in Belgium, France and the Netherlands remain attractive on a risk-adjusted basis over 2018-2022. Improvements in manufacturing output, combined with structural trends such as the growth of e-commerce, have resulted in solid and sustainable occupier demand for good-quality logistics space, and the sector offers relatively high yields. Prime German retail assets should also deliver stable returns, with the sector benefiting from strong consumer spending despite the lingering threat of online disruption. 

…and two risks to the outlook

1. A sharper rise in bond yields

Although it is not our base case, there is a risk that the global bond market might begin to price in a more aggressive rate-hiking cycle by the Federal Reserve and other major central banks. A spike in bond yields would erode the relative attractiveness of real estate and lead investors to turn to other asset classes.

2. A rapid expansion in supply

Supply remains modest across most European real estate markets but development has begun to pick up in some cities (see figure 2), with the office supply pipeline for 2018-’22 exceeding the long-term average in Central Paris, Berlin, Stockholm and Stuttgart. With capital values relatively high and the amount of available space falling, the economics of property development look increasingly favourable, and anecdotal evidence suggests banks are now more willing to move up the risk curve to lend to developers. All this considered, it is possible development might expand more quickly than we anticipate, with a negative impact on rental growth. Investors should monitor new building starts across the continent to ensure they are not caught out by a surfeit of new supply.

Figure 2. Office development picking up in some markets
graph showing rolling annual building as a percentage of stock

    Juncker's State of the EU: “The wind is back in Europe's sails”, EuroparlTV,  14 September 2017

  The scale represents our forecast excess return (total return forecast over the outlook period minus the hurdle rate), expressed as a percentage of the hurdle rate for each sector.


Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.